Mean-Variance Analysis

AAA

DEFINITION of 'Mean-Variance Analysis'

The process of weighing risk (variance) against expected return. By looking at the expected return and variance of an asset, investors attempt to make more efficient investment choices- seeking the lowest variance for a given expected return, or seeking the highest expected return for a given variance level.

Mean variance analysis is a component of modern portfolio theory, which assumes investors make rational decisions, and that for increased risk they expect a higher return. 

BREAKING DOWN 'Mean-Variance Analysis'

There are two major factors in mean variance analysis: variance and expected return. 

  • Variance represents how spread out the data set numbers are, such as the variability in daily or weekly returns of an individual security.
  • The expected return is a subjective probability assessment on the return of the stock. 

If two investments have the same expected return, but one has a lower variance, the one with the lower variance is the better choice.

By combining stocks with different variances and expected returns in a portfolio (diversification), the variance and expected return of the portfolio can be altered as the price moves of one stock may be offset by the price moves of another in the portfolio. 

RELATED TERMS
  1. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  2. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth ...
  3. Return On Investment - ROI

    A performance measure used to evaluate the efficiency of an investment ...
  4. Systematic Manager

    A manager who adjusts a portfolio’s long and short-term positions ...
  5. Unconstrained Investing

    An investment style that does not require a fund or portfolio ...
  6. Altman Z-Score

    The output of a credit-strength test that gauges a publicly traded ...
Related Articles
  1. Investing Basics

    Modern Portfolio Theory vs. Behavioral Finance

    Modern portfolio theory and behavioral finance represent differing schools of thought that attempt to explain investor behavior. Perhaps the easiest way to think about their arguments and positions ...
  2. Fundamental Analysis

    Calculating Covariance For Stocks

    Learn how to figure out how two stocks might move together in the future by calculating covariance.
  3. Investing Basics

    Diversification: Protecting Portfolios From Mass Destruction

    This investing strategy retains its charm as a protection against random events in the market.
  4. Investing Basics

    Introduction To Investment Diversification

    Reducing risk and increasing returns in your portfolio is all about finding the right balance.
  5. Personal Finance

    Diversification: It's All About (Asset) Class

    Frustrated stock pickers rejoice - asset class selection is simpler and safer.
  6. Active Trading

    Modern Portfolio Theory: Why It's Still Hip

    See why investors today still follow this old set of principles that reduce risk and increase returns through diversification.
  7. Bonds & Fixed Income

    Does International Investing Really Offer Diversification?

    Historically, international investing has worked out well for investors, but this may no longer be the case.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares US Basic Materials

    Learn about the iShares US Basic Materials exchange-traded fund, which invests in the equities of chemicals, metals and industrial gas companies.
  9. Term

    What are Mutually Exclusive Events?

    In statistics, mutually exclusive situations involve the occurrence of one event that does not influence or cause another event.
  10. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Commodity Tracking

    Find out about the PowerShares DB Commodity Tracking ETF, and explore a detailed analysis of the fund that tracks 14 distinct commodities using futures contracts.
RELATED FAQS
  1. How reliable is the mean variance analysis of an investment?

    Mean variance analysis of an individual investment or asset can provide a historical measure of volatility for the investment. ... Read Full Answer >>
  2. Can a mean variance analysis be done for any investment?

    A mean variance analysis is performed on a group of assets in a portfolio across a certain time horizon. This analysis can ... Read Full Answer >>
  3. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  4. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  5. What is the difference between passive and active asset management?

    Asset management utilizes two main investment strategies that can be used to generate returns: active asset management and ... Read Full Answer >>
  6. What percentage of a diversified portfolio should large cap stocks comprise?

    The percentage of a diversified investment portfolio that should consist of large-cap stocks depends on an individual investor's ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Stock Market Crash

    A rapid and often unanticipated drop in stock prices. A stock market crash can be the result of major catastrophic events, ...
  2. Financial Crisis

    A situation in which the value of financial institutions or assets drops rapidly. A financial crisis is often associated ...
  3. Election Period

    The period of time during which an investor who owns an extendable or retractable bond must indicate to the issuer whether ...
  4. Shanghai Stock Exchange

    The largest stock exchange in mainland China, the Shanghai Stock Exchange is a nonprofit organization run by the China Securities ...
  5. Dead Cat Bounce

    A temporary recovery from a prolonged decline or bear market, followed by the continuation of the downtrend. A dead cat bounce ...
  6. Bear Market

    A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!